Revision sheet for Actuarial Insurance 1. Game theory/decision theory 1.1.

Consider a two person zero sum game between player A and B, both with strategy sets {1, 2} and with the following payo matrix P : B: 1 2 1 ( 1 0 ) A: 2 ( a 2 ) for some a R. a) If a = 1, show that the entry P21 is a saddle point. b) If a = 2, nd all possible saddle points. 1.2. Suppose you are the decision maker (DM) in a statistical game without data. The action space is {a1 , a2 , a3 }, the possible states of nature are {1 , 2 , 3 } and the corresponding loss matrix is given by DM: a1 a2 ( 1 2 ( 3 0 ( 2 1

1 Nature: 2 3

a3 2 ) 1 ) 0 ).

You use the Bayes criterion to determine your optimal action. a) If the prior distribution is given by a rv with distribution 1 with prob. 1/4 = with prob. 1/4 2 with prob. 1/2, 3 determine your optimal action. b) Suppose now that takes the values 2 and 3 with unknown probability (1 still occurs with prob. 1/4). Denote p := P( = 2 ). For which
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values of p is a2 optimal? 1.3. The European championship soccer 2012, the UK will play the Netherlands in the big nal for the title. You would very much like to attend the match, but as all tickets are sold out your only option is to consider the following oer from a Dutch fan who happens to have a spare ticket. He oers to determine the price you have to pay for the ticket as follows. You are allowed to predict a winner of the match. If it turns out you are right you dont have to pay anything. However if you predict the Netherlands will win and this turns out wrong, you have to pay a very grumpy Dutchman 99, while if you predict the UK will win and this turns out to be wrong you have to pay the very drunk Dutchie only 1. You also have a secret weapon. Namely, a certain Germain octopus is believed to be able to predict the winner of the game and you want to use this prediction for your decision. However, since the Netherlands beat Germany in the semis the ocotpus is a bit frustrated with all that orange and hopes that the UK will win. His prediction is therefore a bit biased: if the UK will win the game the octopus will indeed predict the UK as winner, however if the Netherlands will win then with 20% chance the ocotopus will stubbornly predict that the UK will win. Your aim is to minimize your costs. Formulate this problem as a statistical game with data, i.e. write down the loss matrix, formulate your possible decision functions, derive the corresponding risk matrix and then nd your optimal randomised decision function under the minimax criterion. 1.4. Suppose you are the decision maker (DM) in a statistical game (without data). Your possible actions are a1 and a2 , the possible states of nature are 1 and 2 and the associated loss matrix is as follows: DM: a1 a2 ( 1 b ) ( b 2 )
2

1 Nature: 2

for some b R. Find the value for b in the interval (, 1) such that under the minimax criterion your optimal randomised action is to choose a1 with probability 3/4 and a2 with probability 1/4. 2. Loss distributions 2.1. An insurance company models their incoming claim amounts by a random variable X with pdf fX given by fX (x) =
1 2 x 2x e

for x > 0 for x 0.

Furthermore the company has agreed on an excess of loss reinsurance contract with a reinsurer, with a retention level K > 0. a) If K = 10, what is the probability the insurance company pays an incoming claim completely by itself? b) If K = 10, what is the probability an incoming claim amount is such that the reinsurer has to pay at least 5? c) Suppose the insurer wants to use the excess of loss reinsurance to reduce the expected claim amount they were facing without reinsurance by at least 50%, how should they choose K (rounded to two decimals)? (You may use that the solution to the equation ex (x2 /2 + 2x + 3) = 3/2 is x = 1.61 (rounded to two decimals)). 2.2. Suppose that an insurance company models their incoming claim amounts by a rv X taking values in the interval [0, c] for some (unknown) parameter c, which is known to be at least 11, i.e. c > 11. The rv X has a pdf given by f (x) = Cx if x [0, c] 0 if x [0, c],

where C is some constant. a) Show that C = 2/c2 . b) The company can choose between two types of reinsurance contracts,
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namely contract A which entails proportional reinsurance with retention level 143/343 and contract B which entails excess of loss reinsurance with retention level 11. If the company aims for a maximal reduction in expected claim amount, show that contract B is preferable if and only if c > 77/2. c) The records of the company contain the following incoming claim amounts: 20, 18, 35, 4, 11. Use these to estimate the parameter c by the method of moments, also show that is is unique. Using the answer to b), would you now recommend to choose for contract A or for contract B? 2.3. Suppose that an insurance company models their incoming claim amounts by a rv X following an exponential distribution with parameter > 0, i.e. X has pdf f (x) = ex for x > 0 and f (x) = 0 otherwise. Furthermore there is an excess of loss reinsurance contract in force with a retention level K = 5. As usual we denote by Z the rv modeling the non-zero claim payments the reinsurer had to do. In total 5 accidents have occured with total damage amounts 6, 2, 3, 11 and 8. Of these, the insurance company recorded only the amounts it had to pay, i.e. the minimum of the damage amounts with K. The reinsurance company only has records of the (non-zero) claim payments it had to do. a) Estimate the parameter as it appears in X based on the records the insurance company has using the maximum likelihood method. b) Show that in fact Z also follows an exponential distribution with parameter . (Note: though the name is used in a dierent context, this fact which indeed only occurs for this specic distribution is a consequence of the so-called lack of memory property of exponential distributions.) c) Based on the records the reinsurance company has, estimate the param eter as it appears in Z by both the method of moments (show that it is unique) and the method of maximum likelihood. 2.4. An insurance company models their incoming claim amounts by a rv X which is uniformly distributed on the interval [0, 10], that is, X has pdf fX where fX (x) = 1/10 if x [0, 10] and fX (x) = 0 if x [0, 10]. A reinsurance company oers an advanced reinsurance contract, which oers
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to pay 30% of any claim amount that falls between two bounds K1 and K2 , with 0 < K1 < K2 < 10, but pays none otherwise. a) What is the probability the insurance company has to pay a claim fully by itself? b) Show that the rv Z modeling the non-zero claim payments done by the reinsurer has a pdf fZ given by fZ (z) = 10/(3(K2 K1 )) for z [3K1 /10, 3K2 /10] 0 for z [3K1 /10, 3K2 /10]

3. Run-o triangles 3.1. Consider the following run-o triangle with cumulative claim payments (it is assumed that all claims are closed 4 years after AY): DY 0 1 2 3 221 276 303 310 105 151 182 156 171 206

2007 AY 2008 2009 2010

a) Using the chain ladder method, compute the reserve to be held in 2010, rounded to integers. b) Assuming an ination rate of 4% per year and using the ination adjusted chain ladder method, compute the reserve to be held in 2010 rounded to integers. 3.2. An insurance company has established the following run-o triangle with cumulative claim payments (it is assumed that all claims are closed 3 years after AY):

DY 0 1 2 2008 100 200 a AY 2009 200 b 2010 300 for unknowns a > 200 and b > 200. Given that in 2010 a total of 700 was paid for claims and that using the chain ladder method a reserve of 1300 was computed, nd a and b. 4. Risk models 4.1. Suppose that the annual aggregated claim amount S for an insurer is given by
N

S=
i=1

Xi ,

where the number of claims N takes values in {0, 1, 2} with pmf pN given by pN (0) = 1/2, pN (1) = 2/5 and pN (2) = 1/10. In addition, the claim amounts X1 and X2 are independent, take values in {1, 2, 3} and have common pmf pX given by pX (1) = 1/2, pX (2) = 3/10 and pX (3) = 1/5. a) Compute the expected aggregated claim amount. b) Find the distribution of the sum X1 + X2 . c) Find the distribution of S and use it to verify your answer in a). 4.2. Let S be an aggregated claim amount. a) If S follows a compound Poisson distribution with Poisson parameter , state formulae for the mean and variance of N . b) If S follows a compound binomial distribution with binomial parameters n and p, state formulae for the mean and variance of N . 4.3. Consider an insurance company facing an aggregated claim amount S that follows a compound Poisson distribution with Poisson parameter 5
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and individual claim amounts following a uniform distribution on [0, 10], i.e. they have joint pdf f (x) = 1/10 if x [0, 10] and f (x) = 0 otherwise. a) Compute the mean and variance of S. What is the moment generating function of S? (You may use that the moment generating function of a Poisson distribution with parameter is given by M (t) = exp((et 1)).) b) Suppose the insurance company has eected an excess of loss reinsurance contract with a reinsurer, with retention level K = 5. As usual we denote by SI (resp. SR ) the aggregated claim amount of the insurer (resp. reinsurer) under this contract. Compute the mean and variance of both SI and SR . 4.4. An insurance company holds a portfolio consisting of 100 identical policies. For the coming year it is assumed that each portfolio generates a claim with probability 1/10, independent of the others. The associated claim amounts are assumed to be independent, following a Pareto distribution with the following pdf: f (x) = (1 + x)2 if x > 0 0 if x 0.

Denote the aggregated claim amount over the coming year by S. a) What is the probability at least 2 claims will occur in the coming year? b) What is the probability that the rst incoming claim will be at least as large as 1? In order to reduce the risk they are exposed to the insurance company enters an excess of loss reinsurance agreement with retention level K = 3. As usual we denote by SI (resp. SR ) the aggregated claim amounts over the coming year for the insurer (resp. reinsurer) under this contract, and by N the number of non-zero claim payments the reinsurer has to do during the coming year. c) Show that the probability that the reinsurer does not have to pay anything during the coming year equals (39/40)100 . (Hint: formulate the ques tion using N , and the identity

n=0

m n x = (1 + x)m n

might come in handy.) d) Without referring to the lecture notes , show that the moment generat ing function of N , MN , can be expressed as 1 . MN (t) = 1 + (et 1) 40 You may use that the moment generating function M of a binomial distribution with parameters m and p is given by M (t) = (1 p + pet )m . (Note: the answers to c) and d) above seem to imply in fact, d) is a proof that N follows a binomial distribution with parameters 100 and 1/40. Indeed, if you give it some thought you might realise this is quite logical.)
100

This just means that you cannot use the Lemmas or Theorems we proved in the lecture (notes)